Tag Archives: closed-end-funds

Finding Bargains Among High Income CEFs Selling At Historic Discounts

Summary The discounts associated with CEFs are at historic highs, with many discounts over 2 standard deviations from the mean. The highly discounted CEFs have been significantly more volatile than high yield bonds. MGU and GLO had the best risk-adjusted performance among the CEFs analyzed. As an income focused investor, I was a fan of high distribution Closed End Funds (CEFs). Many of these funds have been hit hard by the Fed’s plans to increase interest rates. As the prices deteriorated, the discounts of these CEFs have widened to historically large levels. This is evidenced by their Z-score, a statistic popularized by Morningstar to measure how far a discount (or premium) is from the mean discount (or premium). The Z-score is computed in terms of standard deviations from the mean so it can be used to rank CEFs. A good source for Z-scores is the CEFAnalysis website . (Thanks to SA author, Left Bank, for his article on where to find Z-scores). A Z-score more negative than minus 2 is relatively rare, occurring less than 2.25% of the time. However, in today’s environment, there are over 150 CEFs that have one year Z-scores more negative than minus 2, which illustrates the current lack of demand for these CEFs. There were too many CEFs to analyze so I reduced the sample size by using the following selection criteria: A Z-score more negative than minus 2.9. This will occur (assuming a normal distribution) less than 0.2% of the time. A history that includes October 12, 2007 (the beginning of the 2008 bear market) A daily average volume greater than 100,000 shares A market cap of at least $100 million. A distribution of 6% or higher The following CEFs satisfy all these criteria. Clough Global Opportunities Fund (NYSEMKT: GLO ). The CEF sells at a discount of 16.7% and has a Z-score of negative 3.59. This CEF has a “go anywhere” philosophy and has a portfolio of 167 securities, with 60% allocated to the equities, 28% to cash alternatives, and 7% to bonds. The fund may also use an option strategy to increase income. The fund uses a high leverage of 52% and has an expense ratio of 2.2%. The distribution is 10.7%, consisting primarily of gains and Return of Capital (ROC). Over the past year, ROC has been used 50% of the time, with the amount of ROC ranging from 30% to 100%. Invesco Credit Opportunities Fund (NYSE: VTA ). This CEF sells at a discount of 15.3% and has a Z-score of negative 3.59. It has a portfolio of 610 securities invested primarily in senior loans (76%) and high yield bonds (18%). The fund uses 33% leverage and has an expense ratio of 2.5%. The distribution is 8.2% with no ROC. Madison Covered Call and Equity Strategy Fund (NYSE: MCN ). This CEF sells at a discount of 15.1% and has a Z-score of negative 3.3. The portfolio consists of 47 securities, with 78% in equities and 20% in short-term debt. The fund does not use leverage and has an expense ratio of 0.8%. The distribution is 9.7% with no ROC. LMP Corporate Loan Fund (NYSE: TLI ). This CEF sells for a discount of 13% and has a Z-score of negative 3.25. The portfolio consists of 268 securities invested primarily in senior loans (87%) and high yield bonds (8%). The fund uses 33% leverage and has an expense ratio of 1.8%. The distribution is 8.4% with no ROC. Macquarie Global Infrastructure Total Return Fund (NYSE: MGU ). This CEF sells for a discount of 16.9% and has a Z-score of negative 3.09. The fund is concentrated with 51 holdings in infrastructure companies (89%) and 6% in master limited partnerships. The fund uses 30% leverage and has an expense ratio of 2.2%. The distribution is 7%, paid from income and capital gains with no ROC. Calamos Convertible Opportunities and Income Fund (NASDAQ: CHI ). This CEF sells at a discount of 11.2% and has a Z-score of negative 3.04. The portfolio consists of 287 securities, with 57% in convertible bonds and 38% in high yield bonds. The fund uses 28% leverage and has an expense ratio of 1.5%. The distribution is 10.8% with 2 months of ROC during the past year. MS Emerging Markets Debt Fund (NYSE: MSD ). This CEF sells for a discount of 18.3% and has a Z-score of negative 2.95. The portfolio consists of 115 emerging market holdings, with 41% investment grade bonds and the rest in high yield bonds. The fund uses only 8% leverage and has an expense ratio of 3.5%. The distribution is 6.6% with no ROC. GDL Fund (NYSE: GDL ). This CEF sells for a discount of 18.1% and has a Z-score of negative 2.9. The fund seeks total return by using arbitrage transactions and investing in reorganizations and spinoffs. It has 159 holdings, with 75% in equity and 21% in Government bonds. It uses 35% leverage and has an expense ratio of 3%. The distribution is 6.5% with only a small amount of ROC over the past year (the distribution for one quarter had 25% ROC). Based on the Z-score, these high income CEFs appear to be bargains, but Z-score is only one metric to consider. I also like to look at the reward-versus-risk over different time frames. In my mind, the best fund is the one that delivers the highest reward for a given level of risk. This article will analyze these CEFs in terms of risk-versus-reward to help you determine which may be right for your portfolio. To assess the performance of the selected CEFs, I plotted the annualized rate of return in excess of the risk free rate (called Excess Mu in the charts) versus the volatility of each of the component funds over the past bear-bull cycle (from October 12, 2007 to August 28, 2015). The risk free rate was set at 0% so that performance could be easily assessed. This plot is shown in Figure 1. Note that the rate of return is based on price, not Net Asset Value (NAV). I used the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) as a reference. (click to enlarge) Figure 1. Risk versus Reward over the bear-bull cycle The plot illustrates that these CEFs have booked a wide range of returns. To better assess the relative performance of these funds, I calculated the Sharpe Ratio. The Sharpe Ratio is a metric, developed by Nobel laureate William Sharpe that measures risk-adjusted performance. It is calculated as the ratio of the excess return over the volatility. This reward-to-risk ratio (assuming that risk is measured by volatility) is a good way to compare peers to assess if higher returns are due to superior investment performance or from taking additional risk. In Figure 1, I plotted a red line that represents the Sharpe Ratio associated with HYG. If an asset is above the line, it has a higher Sharpe Ratio than HYG. Conversely, if an asset is below the line, the reward-to-risk is worse than HYG. Some interesting observations are evident from the figure. High Z-score CEFs are substantially more volatile than HYG. This is not surprising since CEFs can sell at discounts and many use leverage. With the exception of VTA, the CEFs had larger absolute returns than HYG. However, when volatility is factored into the calculation, only 4 CEFs (GDL, GLO, MGU, and MSD) beat HYG on a risk-adjusted basis. Two other CEFs (TLI and MCU) had risk-adjusted performances similar to HYG. Among the CEFs, MSD was the best performer followed by GLO, MGU, and GDL. The worst performer on a risk-adjusted and absolute basis was VTA. These funds utilized different investment strategies, so I wanted to assess how much diversification you might receive by buying multiple funds. To be “diversified,” you want to choose assets such that when some assets are down, others are up. In mathematical terms, you want to select assets that are uncorrelated (or at least not highly correlated) with each other. I calculated the pair-wise correlations associated with the funds. For reference, I also included the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) as a proxy for the overall stock market. The results are presented in Figure 2. (click to enlarge) Figure 2. Correlation over the bear-bull cycle The figure presents what is called a correlation matrix. The symbols for the funds are listed in the first column on the left side of the figure. The symbols are also listed along the first row at the top. The number in the intersection of the row and column is the correlation between the two assets. For example, if you follow VTA to the right for three columns, you will see that the intersection with GLO is 0.650. This indicates that, over the past bear-bull cycle, the price of VTA and GLO were 65% correlated. Note that all assets are 100% correlated with themselves so the values along the diagonal of the matrix are all ones. As shown in the figure, the CEFs were not very correlated with HYG or among themselves. The highest correlation was between SPY and GLO, which was expected since GLO contained a large position in equities. The overall conclusion is that you can obtain diversification by purchasing more than one of these funds. Next, I wanted to see how these funds fared during more recent times so I used a 5-year look-back period. The results are shown in Figure 3 and what a difference a few years made. The CEFs are still more volatile than HYG, but HYG now beats all the CEFs in terms of risk-adjusted performance. MSD fell from being the best performer to the worst, and VTA moved up from being at the bottom to the third best. MGU had by far the best risk-adjusted performance among the CEFs, with GLO coming in second. GDL was again the least volatile but also did not have a high return. (click to enlarge) Figure 3. Risk versus reward over past 5 years My final analysis used a 3-year look-back period, and the results are shown in Figure 4. During this period, GLO, MGU, and MCN were the top performers on a risk-adjusted basis. These CEFs outperformed HYG on both an absolute and risk-adjusted basis. MSD continued its poor performance, booking a negative return. (click to enlarge) Figure 4. Risk versus reward over the past 3 years Bottom Line These large Z-score CEFs had a wide range of performance relative to each other and to HYG. All of these CEFs are much more volatile than high yield bonds so they would only be suitable for risk tolerant investors. These CEFs are at historically wide discounts and may be bargains in terms of discounts but their overall performance left something to be desired. If you want to take a gamble on these funds, I would recommend MGU. GLO could also be considered, but I am a little cautious of this fund’s ROC. No one can predict the future, but based on the past, these two CEFs have consistently outperformed their peers on a risk-adjusted basis. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MGU over the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Vietnam’s Transition From A Frontier Market To An Emerging Market

Summary Vietnam is on track to become an emerging country, with rapid economic growth ahead, and the removal of the FOL in some industries beginning next month. VinaCapital’s Vietnam Opportunity Fund and Vietnam Holdings are attractive options for investors due to their low valuation, and access to shares of companies fully held by foreign investors. Investors should avoid the Market Vectors Vietnam ETF, and consider closed-end funds as the most appropriate means to gain exposure to Vietnam. The recent devaluation has created low valuation in listed equity in Vietnam; this has created a buy opportunity. Vietnam is poised to be a dominant player in Asia, as China’s economy begins to slow down, and Vietnam continues to take key steps towards being an emerging country. The further devaluation of the dong this month has negatively affected listed equities in Vietnam, although it can consequently be viewed as a buy opportunity, given that it has created substantially low valuation for a large portion of listed equities in Vietnam. Issues with the Market Vectors Vietnam ETF VNM data by YCharts The Market Vectors Vietnam ETF (NYSEARCA: VNM ) has been substantially declining due to the dong’s devaluation, although the downward trend in stock price and poor performance is not a new phenomenon for this fund. Although the fund invests more than 70% of its assets in listed equities in Vietnam, its portfolio’s performance has been a poor reflection of Vietnam, as a value based/high dividend yield approach has been extremely successful for other investment funds. Moreover, the fund also suffers due to its inability to access shares of companies fully held by foreign investors. The FOL will be removed in some industries next month , serving as a major catalyst for the financial performance of funds in Vietnam that already have a large portfolio of companies fully held by foreign investors; this benefit will not transfer to the Market Vectors Vietnam ETF. Two closed-end funds, the Vinacapital Vietnam Opportunity Fund ( OTCPK:VCVOF ) and Vietnam Holdings ( OTC:VNMHF ), have substantially lower valuation, and also have shares of companies fully held by foreign investors, most notably Vinamilk. Therefore, the best means for U.S. investors to gain access to the growth that is ahead for Vietnam is through either one of these closed-end funds. Now is a very strategic moment to invest in Vietnam due to the recent decline in stock prices, the upcoming removal of the FOL, and Vietnam’s high economic growth and successful steps taken towards becoming an emerging market. Vietnam’s Macroeconomic Outlook Vietnam has an overall substantially positive macroeconomic outlook: Annual GDP growth was most recently 6.44%, and is projected to increase to 7% by the end of this year. High level of exports , due to the relative advantage of cheap labor, although Vietnam has most recently had a trade deficit of $329 million; exports in Vietnam have, however, doubled in the past five years. Consumer spending has nearly doubled since 2010, and is projected to increase by 26.8% YoY during the 2nd quarter of 2016; this growth trend is clearly not over. Retail sales are projected to increase by 19.6% YoY during the second quarter of 2016; retail sales most recently increased by 26.7% The Vietnamese dong has been a relatively stable currency in Asia, and the FX risk is well worth taking, considering the collective low valuation and high dividend yield of listed equity in Vietnam. Removal of FOL I previously interviewed Vietnam Holdings regarding the removal of the FOL in Vietnam in some industries next month. The process is still very unclear, but this decision made for September certainly serves as a crucial step for increased FDI in Vietnam. The removal of the FOL will be company and industry specific, and based on the following factors: Some industries, such as the banking industry, will choose not to remove the FOL, keeping foreign ownership at 10-30%. The decision to increase the FOL also requires approval from the company. Companies with large SCIC stakes will also be less likely to increase the FOL. Despite the lack of clarity and full initiation next month, this serves as a major catalyst for Vietnam’s stock market. Investment funds that have prepositioned themselves by building up a strong portfolio of companies fully held by foreign investors, even at the painful expense of a 20% premium, are sure to be rewarded in the future. Strength over China As China experiences slowed growth in GDP and exports, Vietnam continues to emerge as a superior alternative for manufacturing, due to its relatively lower wages. A report from Standard Chartered Bank recently stated that relocating to Vietnam could reduce operating costs by 19%; wages in China are expected to continue to rise by 8.4% in 2016. Vietnam can also further benefit from the soon to be initiation of the Trans-Pacific Partnership Agreement. Vietnam also has the relative advantage of lower corporate taxes , which should be lowered from 22% to 20% in 2016, representing a 5% reduction to China’s corporate taxes. Vinacapital Vietnam Opportunity Fund Vietnam Opportunity Fund is a closed-end investment company that invests its assets in listed and unlisted equity in Vietnam and surrounding countries in Asia. Some of these factors make it a strategic pick for the growth that is ahead for Vietnam: High discount : Its London listing trades at an 18.35% discount. Low valuation: The fund has a P/E 10.54, and is trading substantially below its book value, with a P/B of 0.68. The fund invests 15.1% of its assets in Vinamilk and DHG Pharmaceutical, two companies fully held by foreign investors. The 52-week change of -16.6% should be seen as a buy opportunity, as it has created substantially lower valuation. The fund has previously had a higher P/E, and its valuation is lower than the average valuation in Vietnam. High upside potential and low valuation of other listed equity, including Hoa Phat Group (8%) and Petrovietnam Drilling and Well Services (3.8%). Acceptable liquidity: The fund has an average 3-month trading volume of 13,650. Vietnam Holdings Vietnam Holdings is a closed-end investment company that invests its assets exclusively in Vietnam, with a value-based investment approach that incorporates social, environmental, and corporate governance standards. The fund is extremely undervalued, although the liquidity risk should be noted, as its average 3-month trading volume has recently increased to 859; its listing on the London Stock Exchange has substantially higher valuation . The following factors make this fund stand out, and an appropriate means to leverage from Vietnam’s future economic growth: Extremely low valuation : The fund has a P/E of 6.03, and is trading below its book value with a P/B of 0.92. The fund invests approximately 20% of its assets in companies fully held by foreign investors, including Vinamilk, DHG Pharmaceutical, FPT Corporation, and Viconship. The fund has had an impressive 52-week change of 16.92%, yet the valuation is still extremely low. In addition to strategically investing in companies fully held by foreign investors, the fund also has a very successful portfolio of companies with low valuation, including Hoa Phat Group, Petrovietnam Drilling and Well Services, and Binh Minh Plastic. Conclusion Now is a strategic time for investors to turn their attention to Vietnam, due to the strong benefits ahead, and the decline in the price of many funds due to the devaluation of the dong. The upcoming removal of the FOL in September will further serve as a catalyst for increased FDI and economic growth in Vietnam; this is also a crucial step towards Vietnam becoming an emerging market. Vietnam has a very favorable economic outlook, with a projected increase in annual GDP growth, consumer spending, and retail sales. Listed equity in Vietnam has the key advantages of having low valuation and high dividend yields, which can prove to be a valuable endeavor for value investors. Unfortunately, gaining access to this growth in not simple for U.S. investors, as the Market Vectors Vietnam ETF has historically been a poor reflection of Vietnam’s potential. Therefore, U.S. investors should turn their attention towards closed-end funds, which include Vietnam Holdings and VinaCapital Vietnam Opportunities Fund. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Floating Rate Bond Funds: 7% Income And Appreciation Potential

Summary Floating Rate CEFs like JFR are currently yielding 7% with huge 13% discounts to net asset value. Exposure to energy is only 3% (and net asset value reflects current prices). Prices fell as investors pulled funds in anticipation of Fed rate hike, leaving little downside and potential upside as any increases are likely to be moderate and investors flee equities. Floating rate securities, like the Nuveen Floating Rate Income Fund (NYSE: JFR ) fund have served as a bond alternative in my portfolio. The fund typically invests in debt that has an adjustable feature, where the interest rate is based on a margin over LIBOR. These securities have yielded 6%-7% over the past year and can provide strong returns. JFR and its ilk are ‘Closed End funds’, which can trade at a premium or discount to the underlying assets. In recent months, discounts have widened, which may signal an opportunity. The underlying investments of funds like JFR are bond-like products that provide the benefits of (relatively) high yielding senior, secured bonds with protection against rising interest rates and inflation. As mentioned above, the protection is derived from a margin over a LIBOR floor (e.g. 30 day LIBOR plus 700 basis points). Every fund is different, but generally, +/- 90% of the investments are loans with B, BB or BBB credit quality. Source: Nuveen If you are intrigued by closed end floating rate funds, there are to choose from. The four highlighted funds, all with Morningstar rankings of 4 stars or better are certainly worth closer inspection. Source: Morningstar (M* is Morningstar) While there has been a modest amount of decline in asset values (bond prices decline as interest rates rise and interest rates have been rising in anticipation of the Fed increasing interest rates), the values of the funds have fallen much more than the underlying change in asset values. The increased drop is reflected in the current discount (in the above chart). As you can see, every fund listed has seen an increase in discount to net asset value of between 220 and 460 basis points. This is a huge manifestation of these securities falling out of favor. However, they create an opportunity for buyers. (click to enlarge) Source: Morningstar As the above chart shows, net asset values are similar to those in mid-December, but the discount has widened significantly (especially in the last few weeks). The catalyst for the widening of spreads was likely a sale of JFR (in the example) in anticipation of the Fed increasing rates. Please consider these points: Any Fed increase is already “baked into” the market. Most observers expect the Fed to either delay or be very cautious with respect to raising rates due to low inflation and the negative impact of a strong dollar on the U.S. economy (higher interest rates will likely to cause the U.S. Dollar to further appreciate, making exports less competitive). Current volatility in the stock markets may cause a subset of investors to look for alternate investments; the same supply/demand equation which has driven the current high discount can reverse. Risk is mitigated through company and industry diversification, with the top ten holdings of a fund typically representing less than 20% of the funds investable assets. Similarly, industry diversification is also maintained, with no one industry type receiving more than 20% of a fund’s investable assets. The below tables represents the top ten holdings and industry diversification of my favorite floating rate bank loan fund, JFR ( Nuveen Floating Rate Income Fund ) as of July 31, 2015. Top Ten Holdings of JFR (Source: Nuveen) Holdings by Industry of JFR (Source: Nuveen) Investment returns are commonly enhanced by leverage, typically between 25%-40%. In the case of JFR, leverage was 38.1% at July 31, 2015 (Source: Nuveen). Fees Because of the unique nature of bank loans, there really needs to be an element of human involvement in assessing the underlying securities. Therefore, these funds typically carry hefty management fees and expenses. Paying professional management is contrary to my investing style, but given the need to assess and monitor, I make an exception in the case of floating- rate senior bank loans. As an example, JFR fees are currently running at an annualized 2.05% (including leverage costs). A Discussion on Risk- Macro Nothing in life is without risk. The underlying assets of floating-rate senior bank loans, while offering first lien position in investment grade securities do default on occasion. According to a study by Moody’s Investors Service, the average annual default rate on senior floating-rate loans has historically (including the recent recession) been 3.4% (1996-2012). The same analysis highlights a 71.1% recovery rate on these same loans over the same period. Ignoring the time to recovery, the data suggest that an annual loss rate of 1.0% is to be expected (3.4% x 28.9% non-recovered) in an average year. Logically, the loss rate would tend to be less in times of economic expansion and greater in times of economic contraction or recession. A Discussion on Risk- Micro JFR’s energy holdings represent less than 3% (in dollars) of current holdings (as of Nuveen data analyzed August 21). Any declines in these bonds are already reflected in net asset value. Further, about 90% of JFR’s holdings trade for 99 or more, which given bid-ask spreads mean the vast majority of JFR’s bonds are doing fine and trading for par (even after price drops due to rate concerns). Foreign holdings represent about 14% of total investments; however these bonds tend to be denominated in, and pay interest in, dollars. Potential Performance in Today’s Stable-to-Rising Rate Environment In addition to a monthly payment, which currently is an annualized 7%, there is the prospect of appreciation (on the closed end funds) as discounts decline from today’s 12%-13% to a more moderate 5%-7% or even a more normalized 3%-4%. Further, according to a study by Vanguard, the performance of floating-rate products during a period of rising rates outperforms the bond market by 4.3% (see an excellent discussion from Vanguard on floating-rate bond funds). Summary Floating-rate securities offer an opportunity to capture income, with appreciation potential and modest risk compared to bonds. The floating rate feature of the securities provides protection in the event interest rates do rise materially which the yield and opportunity to close the discount-to-net asset value provides income and appreciation potential. Disclosure: I am/we are long JFR. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.